The foundations of private funds: 3(c)(1) and 3(c)(7)

Private Assets

November 14, 2024

Table of Contents

Key takeaways

Private funds differ from public ones and are often formed under section 3(c)(1) or 3(c)(7) of the 1940 Investment Company Act, known simply as the “‘40 Act”.
3(c)(1) funds allow accredited investors to invest, but are limited to only 100 investors. 3(c)(7) funds, in contrast, require qualified purchaser accreditation, but can accept up to 2,000 investors.
Although private funds enjoy '40 Act exemptions, they are not unregulated, and are subject to anti-fraud and other securities regulations.

Investment ideas

The ‘40 Act

Private funds pool capital from various investors to invest in a range of assets, including private equity, venture capital, real estate, and infrastructure. These funds are typically not registered with the Securities and Exchange Commission (SEC) and are limited to a specific number of “sophisticated” investors. The structure of these funds must nevertheless adhere to specific regulatory frameworks that were laid out in the 1940 Investment Company Act (the ‘40 Act).

The ‘40 Act primarily focuses on regulating public investment funds, including mutual funds and exchange-traded funds (ETFs). However, private funds often file for exemptions to the ‘40 Act found in Sections 3(c)(1) and 3(c)(7). Under these exemptions private funds are not required to register or be regulated as investment companies under federal securities laws, but - as such - they cannot offer their securities publicly.

3(c)(1) funds

A 3(c)(1) fund is limited to a maximum of 100 accredited investors, or “beneficial owners”. While the fund is limited in terms of the number of investors, there are no restrictions on assets under management.

To invest in a 3(c)(1) fund, all beneficial owners must meet the "accredited investor" criteria, which are:

Individuals with a net worth exceeding $1M (excluding the value of their primary residence); or
Individuals with an annual income exceeding $200,000 ($300,000 for joint income) in the last two years and the expectation of the same income level in the current year; or
Entities, such as trusts or corporations, with assets exceeding $5M

3(c)(7) funds

A 3(c)(7) fund is for investors that meet "qualified purchaser" criteria. Under the 3(c)(7) exemption, a fund may have up to 2,000 investors, after which it will need to be registered as an investment company under the ‘40 Act. As with 3(c)(1) funds, there are no limits on assets under management.

Qualified purchasers are:

Individuals with at least $5M in investments, or
Institutions with at least $25M in investments

Private funds are not, however, unregulated. While 3(c)(1) and 3(c)(7) funds are not registered as investment companies, they are very much subject to anti-fraud provisions and must comply with other securities laws.

Our partners benefit from across-the-board advice on the appropriate fund structure, which will depend on the target profile of your clients and the goal of the fund, among other factors.

Endnotes

¹This is a summary of the law and is provided for informational purposes only. It is not intended as legal advice and should not be relied upon as such. Please consult with qualified legal counsel to obtain advice regarding your specific situation.

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