Hedge funds accept investors based on many considerations, including: wealth, sophistication, ability to absorb losses, tax status, citizenship, and more. Hedge funds must choose investors carefully because the exemption from registration that hedge funds utilize require that the fund only accept subscriptions from wealthy and sophisticated investors who can either withstand the loss of their investment or who invest with substantial knowledge of the attendant risks.
A domestic hedge fund, structured as a 3(c)(1) fund, can generally accept up to 35 investors that are not “accredited investors,” as defined by the Securities Act of 1933. The rest of the fund’s investors must be accredited investors. Individual investors with a net worth greater than $1 million (excluding the value of such investor’s primary residence) are considered to be “accredited investors.” An individual who makes more than $200,000 per year (or $300,000 jointly with a spouse) will also generally be considered an “accredited investor.”
Investors that are not accredited must certify that they are sophisticated enough to understand the risks of the an investment in the fund, and that they, or their financial advisor have carefully reviewed the fund’s offering documents. Institutional or entity investors must meet different criteria to be considered accredited. There are also limits on the amount of money a hedge fund may accept from retirement plans (ERISA plans).
The investor eligibility criteria can become very complicated depending on where the fund’s manager is located, exemption or registration status, the fund’s investment strategy, and other factors. It is critical to consult a qualified hedge fund attorney prior to launching a hedge fund to gain a clear understanding of investor eligibility issues.