[2017 EDITORS NOTE: this article will be updated shortly. Please note that the definition has changed and that the net worth requirement now carves out any equity or debt of a personal residence.]
Hedge fund managers can only admit certain investors into their hedge funds. Most hedge funds are structured as private placements relying on the Regulation D 506 offering rules. Under the Reg D rules, investors must generally be “accredited investors.” Many hedge funds have additional requirements.
With regard to individual investors, the most common of the below requirements is the $1 million net worth (which does include assets such as a personal residence). With regard to institutional investors, the most commonly used category is probably #3 below, an entity with at least $5 million in assets. Please note that there may be additional requirements for your individual hedge fund so you should discuss any questions you have with your attorney.
The accredited investor definition can be found in the Securities Act of 1933. The definition is:
Accredited investor shall mean any person who comes within any of the following categories, or who the issuer [the hedge fund] reasonably believes comes within any of the following categories, at the time of the sale of the securities [the interests in the hedge fund] to that person:
1. Any bank as defined in section 3(a)(2) of the [Securities] Act, or any savings and loan association or other institution as defined in section 3(a)(5)(A) of the Act whether acting in its individual or fiduciary capacity; any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; any insurance company as defined in section 2(a)(13) of the Act; any investment company registered under the Investment Company Act of 1940 or a business development company as defined in section 2(a)(48) of that Act; any Small Business Investment Company licensed by the U.S. Small Business Administration under section 301(c) or (d) of the Small Business Investment Act of 1958; any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, if such plan has total assets in excess of $5,000,000; any employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974 if the investment decision is made by a plan fiduciary, as defined in section 3(21) of such act, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors;
2. Any private business development company as defined in section 202(a)(22) of the Investment Advisers Act of 1940;
3. Any organization described in section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5,000,000;
4. Any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer;
5. Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of his purchase exceeds $1,000,000;
6. Any natural person who had 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 in each of those years and has a reasonable expectation of reaching the same income level in the current year;
7. Any trust, with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a sophisticated person as described in Rule 506(b)(2)(ii) and
8. Any entity in which all of the equity owners are accredited investors.