Accredited Investor vs. Qualified Purchaser: What's the Difference?

Investors who meet certain criteria may be designated as an accredited investor or as a qualified purchaser. These investors are allowed to invest in certain securities that are not registered with the Securities and Exchange Commission. In looking at an accredited investor versus a qualified purchaser, there are some differences to keep in mind.

Among the securities generally requiring that those who invest in them be either qualified purchasers or accredited investors are:

• Hedge funds
• Venture capital funds
• Private equity funds
• Private securities
• Convertible securities
• Private real estate funds

What is an accredited investor?

An accredited investor in the United States is a person considered to be financially sophisticated and has less of a need for protections provided by regulatory filings. Accredited investors include high-net-worth individuals, plus institutional investors including banks, insurance companies and brokers. Some trusts also qualify for accredited investor status.

For an individual to qualify as an accredited investor, they must meet these requirements:

• Have an annual income of $200,000 as an individual or $300,000 as a married couple for each of the past two years. They must also have the expectation of earning at least this much income in the current year. Investors must have met these thresholds either as an individual or with a spouse in each of the two prior years.
• Alternatively, an individual can qualify as an accredited investor if they have at least $1 million in net worth. This can be held on their own or jointly with a spouse (or a spouse equivalent). The value of their primary residence cannot be included in this calculation.
• Individuals who hold a FINRA Series 7, 65 or 82 license in good standing.

Additionally, there are other categories of accredited investors, including:

• A trust with total assets in excess of $5 million. The trust cannot have been formed for the sole purpose of purchasing specific non-regulated securities, and the purchase of non-regulated securities will be directed by someone the SEC would consider to be a sophisticated investor.
• Certain entities holding total investments in excess of $5 million that were not formed for the sole purpose of purchasing specific securities.
• An entity in which all of the owners are accredited investors.

What is a qualified purchaser?

The SEC bases the qualified purchaser status on the value of the investments held by an individual or an entity. Their net worth is not considered in making this determination. To be considered as a qualified purchaser by the SEC, at least one of these criteria must be met:

• An individual investor or a family-owned business that holds at least $5 million in investments. If a family-owned business, the company cannot have been formed for the sole purpose of purchasing a specific fund or other unregulated investment.
• A trust that is sponsored or managed by one or more qualified purchasers. The sole reason for the formation of the trust cannot be for the purchase of a specific investment or fund. Alternatively, a trust with at least $5 million in investments that is controlled by at least two close family members such as siblings, spouses or other heirs.
• The qualified purchaser is an individual or an entity that invests at least $25 million either for their own accounts or on behalf of other investors. The entity cannot have been formed for the sole purpose of investing in a specific fund or investment.
• Any entity where all owners are qualified purchasers.

What is the difference between accredited investor and qualified purchaser?

Both accredited investors and qualified purchasers are able to invest in unregistered private investment opportunities that are generally not available to the investing public at large. These investment opportunities might include private equity funds, hedge funds and other types of pooled investments that are not required to be registered with the SEC as an investment company under the Investment Company Act of 1940.

While there are a number of similarities between these two classes of investors, there are also some differences.

First, accredited investors must meet certain hurdles in terms of their income or net worth. Qualified purchasers are determined based on the amount of investments they hold. Net worth does not figure into the calculation to determine whether an individual or entity meets the requirements to be considered as a qualified purchaser.

Accredited investors are allowed to invest in 3(c)(1) funds, which the SEC defines as a “pooled investment vehicle that is excluded from definition of investment company in the Investment Company Act because it has no more than 100 beneficial owners (or in the case of a qualifying venture capital fund 250 beneficial owners).”

Examples of the types of investments available to accredited investors that are not available to the general investing public can include:

• Hedge funds
• Private equity funds
• Private REITs and other private real estate funds
• Private placements
• Convertible securities
• Venture capital funds
• Crowdfunding

It is often said that most qualified purchasers are accredited investors, but the reverse isn’t true. The threshold to be considered a qualified purchaser is higher than that for an accredited investor. The $5 million investment threshold may exclude many accredited investors from reaching qualified purchaser status, but most qualified purchasers likely meet the income or net worth requirements needed for accredited investor status.

Qualified purchasers are allowed to invest in the 3(c)(1) funds open to accredited investors, as well as in 3(c)(7) funds, which are regulated by section 3(c)(7) of the Investment Company Act of 1940. These funds can have up to 1,999 investors before falling under the rules of the Securities Exchange Act of 1934 compared to the lower limits on 3(c)(1) funds.

This often means that these funds may be larger than those available to accredited investors. The advantage to those offering new funds like hedge funds, venture capital funds, private equity investments and similar funds is that they can attract a larger pool of investors and likely more capital by registering the fund as a 3(c)(7) fund.

What does this mean for your clients?

As with any investment that your client might express interest in or that you might recommend to them, it’s important that any investment falling under either the 3(c)(1) or 3(c)(7) classification is appropriate for your client based on their risk tolerance and overall situation.

Many of these private funds represent alternative investments, which can help in diversifying client portfolios where appropriate. Along with these diversification benefits can come liquidity issues, however. Most of these funds limit investor access to their money, so it’s important to be sure this works for your clients before suggesting they invest there.

If you are an investor in or otherwise involved with a private fund, it’s important that you ensure there are no conflicts of interest, real or perceived, with your recommendation of the fund to clients. This is important to document, especially if you are held to a fiduciary standard as an advisor.

The status of accredited investor or qualified purchaser implies a certain level of investing sophistication and can expand the universe of investments open to these investors. It’s important that they perform their due diligence on any private fund before investing; in many cases your clients will look to you for guidance here.

(Image: Adobe Stock)