Starting a Private Fund: Sponsor FAQs

In this post, we answer some of our most commonly asked questions from sponsors that are considering starting a private fund. For further reading on this topic, click here to check out related articles and videos.


What makes the fund a “Private Fund”?

Private funds are pooled investment vehicles that are excluded from the definition of “investment company” under the Investment Company Act of 1940. The term private fund generally includes funds commonly known as hedge funds and private equity funds. In general, these funds are “private” in two ways: (1) private in terms of how funds are raised; and (2) private in terms of the number and type of investor.


What laws govern the formation and operation of a Private Fund?

Private funds operate at the intersection of three federal regulatory regimes:

  1. The Securities Act of 1933;

  2. The Investment Company Act of 1940; and

  3. The Investment Advisers Act of 1940

A private fund must navigate these three bodies of law to comply with reporting and disclosure requirements and to satisfy exemptions from registration thereunder.


What exemptions are available under the Investment Company Act?

The exemptions under Investment Company Act (the “ICA”) that are typically used by private funds are commonly known as the “3(c)(1) fund” exemption or the “3(c)(7) fund” exemption. These names refer to the sections under the ICA that provide for two separate exemptions from the regulations imposed on “investment companies” under the ICA.

The definition of “investment company” under the ICA is a company that “holds itself out as being engaged primarily or proposes to engage primarily, in the business of investing, reinvesting or trading in securities.” This broad definition would include nearly all private funds, except that the ICA includes certain exemptions meant to exclude private funds from the ICA’s onerous requirements (e.g. SEC registration, ongoing disclosure requirements, disinterested directors, and its prohibitions on certain transactions).

To be exempt from registration as an “investment company” and the requirements applicable to the operation of an “investment company” under the ICA, the two most used exemptions require the following:

  1. The fund does not make, or propose to make, a public offering of its securities; and

  2. The fund’s investors are either:

    • limited to no more than 100 investors (known as “the 3(c)(1) fund” exemption); or

    • all “qualified purchasers” as defined in the ICA (known as “the 3(c)(7) fund” exemption)


What exemptions are available under the Investment Advisers Act?

A person is exempt from the Investment Adviser Act (“IAA”) registration requirements with the SEC if the person satisfies the following exemptions:

Private Fund Adviser Exemption: The “private fund adviser exemption” exempts from SEC registration an investment adviser that acts as an adviser solely to private funds (i.e. funds that are exempt from the definition of an “investment company” under 3(c)(1) or 3(c)(7) under the ICA) and has total “regulatory assets under management” that are less than $150 million.

Venture Capital Fund Adviser Exemption: The “venture capital fund adviser exemption” exempts from SEC registration an investment adviser that acts as an adviser solely to 1 or more “venture capital funds” (as defined by SEC regulations).


What is an “Exempt Reporting Adviser”?

Investment Advisers that are exempt from SEC registration under the IAA (e.g. private fund advisers and venture capital fund advisers), may still be required to file annual reports as an “exempt reporting advisor” using a short version of Form ADV. Many states also require private fund advisers to file annual reports as “exempt reporting advisers”.


What type of investors can I allow into my Private Fund?

There are three categories of investors defined under the various federal regulatory regimes discussed above: Accredited Investors, Qualified Clients, and Qualified Purchasers. A fund manager must structure the marketing of a fund to ensure that it only accepts investments from investors that satisfy the applicable definitions as the category of investor can determine whether the private fund qualifies for a private placement exemption, whether a fund’s manager will be entitled to receive performance-based compensation, and whether the fund qualifies for an exemption from registration under the ICA.

All private funds should limit investment in the fund to Accredited Investors as this is crucial to qualifying the offering as a private placement, which avoids registration under the Securities Act and is the first prong to qualify for an exemption from registration under the ICA. If the fund manager is required to register with the SEC under the IAA or is located in a state that regulates performance fees, investments in the private fund should be limited to investors that are both Accredited Investors and Qualified Clients. Finally, if the private fund is relying on the “the 3(c)(7) fund” exemption under the ICA, it must limit investment by investors that qualify as Qualified Purchasers.


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