Qualified purchaser vs accredited investor – What you need to know

Key Takeaways

• Qualified purchasers need $5 million in investments; accredited investors require $1 million net worth or $200,000 annual income.

• Qualified purchasers can access more investment options, including larger 3(c)(7) funds.

• These classifications limit risky investments to wealthy individuals, sparking debate about fairness.
  

The access to certain investment opportunities is governed by a number of regulatory classifications. In this regard, qualified purchasers and accredited investors are the two most frequent classifications.

Individuals who fall into these categories are allowed to participate in certain offerings that are not registered with the SEC. In general, this refers to shares that are issued by privately held companies and startups rather than being sold on public markets. Such investments can be risky, but the potential reward can be great too.

While qualified purchasers and accredited investors are both able to invest in certain private investment opportunities, there are differences in the two classifications. There are also differences in the specific investments that each can make. With that in mind, let’s take a look at qualified purchasers vs accredited investors and outline what you need to know about each of them.

What is a Qualified Purchaser?

The simple definition is that qualified purchaser status is given to a person or a family business holding an investment portfolio with a value of $5 million or more. Elements of the portfolio in question may not include a primary residence, nor property used in the normal conduct of business. 

Alternatively, a single person can operate on behalf of a consortium of individuals who hold qualified purchaser status — and the capability of investing $25 million or more — with the same property-related exclusions noted above. 

Further, a trust can hold qualified purchaser status if it has a portfolio with a value of at least $5 million and is owned by at least two close members of a familial unit. The owners can include spouses and siblings, as well as children of the lead investor and the spouses of those offspring. 

Qualified institutional buyers are also eligible to be considered qualified purchasers under Rule 144A, as long as they hold over $100M in investments. Rule 144A is an SEC regulation that grants purchasers of securities the permission to resell those securities to qualified institutional buyers (QIBs). In other words, Rule 144A simplifies selling private securities to large, sophisticated institutions. To do this, the seller must verify the buyer is eligible and aware of the rule. The securities also must not be listed on public exchanges, and buyers should be able to get more information from the issuer.

Qualified Purchasers and The Investment Company Act of 1940

Privately held capital firms are considered investment companies under the tenets of the 1940 Investment Company Act (“the ‘40 Act”) when they make — or propose to make — public offerings of which qualified purchasers are not among the sole holders of its outstanding securities. 

The ‘40 Act considers qualified purchasers to be those who meet the criteria outlined above. This, in turn, means funds selling only to qualified purchasers are exempt from regulation under the ’40 Act. In other words, investment companies are not required to adhere to certain SEC requirements when they choose to work exclusively with qualified purchasers. 

Under Section 2(a)(51) of the Investment Company Act, a “qualified purchaser” is:

• A person holding $5 million or more in investments
• A company holding $5 million or in investments owned by close family members
• A trust, albeit not one formed specifically for the investment in question, holding $5 million or more in investments
• An investment manager with $25 million or more under management
• A company holding $25 million or more in investments

Determining Qualified Purchaser Status

Unregistered securities issuers are tasked with confirming that investors meet the requirements to be considered qualified investors. As an example, in a situation involving a startup investment through a venture fund, the private equity firm is considered the general partner (GP), while investors are looked upon as limited partners (LPs). 

While the actual steps involved can vary according to the nature of the unregistered securities on offer, typical LP documentation that GPs must consider includes tax returns, W-2s, bank statements and brokerage statements for asset-based accreditation. Proof of accreditation, which can be obtained through a variety of methods according to the SEC’s new definitions,  must be provided by a potential LP as well. 

Investments suitable for the purposes of serving as a foundation for the conferring of qualified purchaser status include the following:

1. Securities such as stocks, bonds and notes — aside from those of a third-party issuer currently held under common control with the entity seeking qualified purchaser status.
2. Real estate held exclusively for investment purposes — primary residences and/or property used in the everyday conduct of the entity’s business cannot be considered. 
3. Commodity futures contracts, options on commodity futures and options on physical commodities traded on a contract market or board of trade held for investment purposes.
4. Stockpiles of physical commodities such as precious metals, held specifically for the purposes of investment, as long as futures contracts in these commodities are traded on a contract market or a board of trade.
5. Swaps and similar individually negotiated financial instruments — aside from securities — held specifically for the purpose of investment. 
6. Binding capital commitments of an investment company or commodity pool. 
7. Liquid assets held exclusively for the purpose of investment. Cash employed to meet everyday expenses by the investor is exempt from consideration. So too is the day-to-day working capital of a company.

Benefits of Qualified Purchaser Status

Among the advantages of holding qualified purchaser status is the ability to participate in a broader range of investment opportunities than is open to accredited investors, as you will see below. 

What is an Accredited Investor?

Under Rule 501(a) of the Securities Act of 1933, only individuals with a net worth (or a joint net worth in the case of a married couple) in excess of one million dollars (excluding primary residence) can be considered accredited investors (or qualified investors). However, instead of that net worth, an individual must be capable of demonstrating an annual individual income of $200K or greater. That income must exceed $300K annually if joint status is sought. 

Further, this income level must be demonstrable for each of the two years immediately prior to seeking accreditation. The investor(s) could also demonstrate that it will be maintained in the current year.

Possession of a FINRA Series 7, Series 65, or Series 82 financial securities license is another way to obtain accreditation outside of net worth requirements.

Attaining accredited investor status through a trust is also possible, providing said trust holds assets in excess of $5 million and was not formed specifically to invest in one particular fund. A person with a demonstrable ability to evaluate the upsides and downsides of a given investment (also known as a sophisticated investor) must guide the trust. The idea here is to protect individual investors by ensuring they have the expertise required to adequately evaluate an investment — along with more than enough money in reserve to weather the situation if an investment does not perform as anticipated. 

Benefits of Accredited Investor Status

Accredited investors invest in funds with fairly strict limits regarding the size of the investor pool. Known as 3(c)(1) funds, they are typically limited to 100 accredited investors. This number can be expanded to 250 investors if the size of the fund is $10 million or less. 

Qualified Purchaser vs Accredited Investor

It can be said all qualified purchasers are likely to be accredited investors, but accredited investors are not necessarily qualified purchasers. The reason for this is that the threshold to obtain qualified purchaser status is higher than that of the accredited investor. 

After all, qualified purchasers must be capable of investing $5 million or more on their own, which means they will likely meet the $1 million net worth requirement to be considered an accredited investor. Granted, the two don’t always go hand in hand, but they do align more often than not.

Thus, in addition to the 3(c)(1) funds open to accredited investors, qualified purchasers have access to 3(c)(7) funds. These funds can accommodate as many as 2,000 qualified purchasers, compared to the much lower limits allowed by 3(c) (1) funds. 

What securities require accreditation?

In order to invest in certain securities, investors must meet either accredited investor or qualified purchaser status. Below are securities that generally require this status:

• Hedge funds 
• Venture capital funds 
• Private equity investments 
• Convertible securities 
• Private real estate funds 
• Equity crowdfunding

Key Distinctions Between Qualified Purchaser vs Accredited Investor

To sum it all up: while there is some overlap in the investment opportunities that are available to both qualified purchasers and accredited investors, here are the key distinctions between the two:

1. In terms of investment criteria, qualified purchasers are defined based on the value of their investments. In their turn, accredited investors are defined based on annual income and net worth.
2. Qualified purchasers have broader investment opportunities than accredited investors. They can invest in both 3(c)(1) funds and 3(c)(7) funds. Accredited investors, on the other hand, are limited to investing in 3(c)(1) funds.
3. In terms of limitations, while both can invest in the above funds, 3(c)(1) funds are limited to 100 accredited investors or 250 accredited investors under certain conditions. In this way, qualified purchasers are able to participate in funds with a larger investor base.
4. Accredited investors and qualified purchasers are subject to different regulatory requirements. Accredited investors are subject to securities laws and regulations, while qualified purchasers have additional exemptions from SEC regulations.
5. Last but not least, all qualified purchasers qualify as accredited investors, but not vice versa.

Why This Matters

The SEC is serious about protecting small investors, both from themselves and from slick market operators. Limiting participation in the most risky investment categories to people who have the experience and financial wherewithal to absorb the aftermath of a large investment gone wrong helps insulate the general public from such occurrences. 

Keep in mind, unregulated investments typically have no reporting or disclosure requirements and they tend to be illiquid in nature. Those who don’t have the means to deal with losses of this magnitude, nor the experience and sophistication to understand them, are thought to be better off excluded from them. 

However, this also eliminates many people from sharing the upside opportunities that investments of this nature offer. Still though, given the events leading up to some of the previous recessions, it is believed the general public is better off insulated from the temptation these offerings can present. Thus, in order to attain qualified purchaser or accredited investor status, one must be an experienced investor with the means to absorb potentially significant losses.

Change is Afoot

On the other hand, regulators have come under intense pressure of late to relax some of these standards to broaden the pool of individuals permitted to invest in opportunities such as pre-IPO startups. The fairness of limiting the possibility of realizing the potentially significant yields these investments can provide to those who are already well off is increasingly coming into question. 

Meanwhile, Willow Wealth already opens a number of investment strategies that were formerly available only to institutional investors and the top one percent of earners to all investors. The company can help you capitalize on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of unique alternative investments.