Private Funds

Because these funds skip ICA registration, they carry less mandated disclosure and less liquidity than a mutual fund or ETF. That tradeoff is the reason the exam gates access to accredited investors and qualified purchasers.

What Exemptions Let a Private Fund Avoid ICA Registration?

Private funds avoid registration under the ICA by using one of two exemptions:

Small-investor exemption exception: Qualifying venture capital funds may have up to 250 investors if the fund has $12 million or less in assets under management (AUM).

Both exemptions share one more condition: the fund must not be making, and must not presently propose to make, a public offering of its securities. This is why private funds are sold as private placements rather than through a public offering, regardless of which exemption applies.

Think of it this way: Private funds use these exemptions to avoid SEC registration. The logic is: if you only have sophisticated wealthy investors who can do their own due diligence, you do not need the same consumer protections required for everyday retail investors.

How Does Accredited Investor Differ From Qualified Purchaser?

Accredited investor net worth/income applies individually or with a spouse/spousal equivalent. Qualified purchaser thresholds are based on investments owned, not net worth, and exclude the primary residence.

Memory Aid: 1-2-3 (Accredited Investor)

• 1 = $1 million net worth (excluding primary residence)
• 2 = $200,000 individual income (each of the last 2 years)
• 3 = $300,000 joint income with spouse (each of the last 2 years)

Qualified purchaser is a higher standard than accredited investor. All qualified purchasers are accredited, but not all accredited investors are qualified purchasers.

Automatic accredited investor status by license:

• Holders of Series 7, Series 65, or Series 82 licenses in good standing also qualify as accredited investors.

Exam Tip: Gotchas

• Accredited investor is based on NET WORTH or INCOME. Qualified purchaser is based on INVESTMENTS owned. A person with a $6 million house and $2 million in investments is NOT a qualified purchaser despite having high net worth.
• The small-investor exemption caps a private fund at 100 beneficial owners (typically accredited). The qualified-purchaser exemption has no investor-number limit, but every investor must be a qualified purchaser.

What Are Hedge Funds?

Hedge funds are actively managed private funds using aggressive strategies to seek returns in any market condition.

Key characteristics:

• Typically organized as limited partnerships (general partner (GP) manages, limited partners (LPs) invest)
• Strategies include: long/short equity, leverage, short selling, derivatives, arbitrage, global macro
• Management fee (commonly 2%) + performance/incentive fee (commonly 20%), known as the "2 and 20" structure
• Lock-up periods restrict redemptions (often 1-2 years)
• Redemption typically only at specified intervals (quarterly, annually) with advance notice
• Less transparent; not required to disclose holdings publicly
• Higher risk profile due to leverage and concentrated strategies
• Exempt from ICA registration via the small-investor private-fund exemption or the qualified-purchaser private-fund exemption
• Fund manager may register as an investment adviser with the SEC under the Investment Advisers Act of 1940

Exam Tip: Gotchas

• Lock-up periods add liquidity risk but allow the manager to use illiquid strategies without being forced to sell.
• Long/short equity is the most common hedge fund strategy.

What Is Private Equity?

Private equity funds invest in private companies (or take public companies private). They have a long investment horizon, typically 7-10+ years for fund life.

Key characteristics:

• Capital is called (drawn down) from investors over time as deals are found
• Returns realized through exits: IPO, sale to another company, or recapitalization
• Buyout funds: acquire controlling stakes in mature companies
• Growth equity: minority stakes in growing companies
• Very illiquid; investors commit capital for the life of the fund
• Typically structured as limited partnerships

What Is Venture Capital?

Venture capital is a subset of private equity focused on early-stage and startup companies.

Key characteristics:

• Higher risk/higher potential return than traditional private equity (PE)
• Invest in companies with limited or no revenue history
• Fund life typically 10+ years
• Capital called over time as investments are made
• Most portfolio companies will fail; returns driven by a few big winners
• Advisers managing only venture capital (VC) funds may be exempt from SEC registration, filing instead as exempt reporting advisers (ERA)

How Do Hedge Funds, Private Equity, and Venture Capital Compare?

Exam Tip: Gotchas

• Hedge funds = liquid strategies in public markets. Private equity = buying established private/public companies. Venture capital = funding startups. All three are private funds exempt from ICA registration.
• Private funds have limited liquidity. Lock-up periods and redemption restrictions are common.

What Should You Check on Exam Day?

• Can you name the two ICA exemptions private funds rely on and the investor-count/type limit each one imposes?
• Do you remember the venture capital exception that raises the 100-investor cap to 250 for funds with $12 million or less in assets under management (AUM)?
• Can you distinguish accredited investor (net worth or income) from qualified purchaser (investments owned), and state each dollar threshold?
• Do you know which securities licenses (Series 7, 65, 82) confer automatic accredited investor status?
• Can you match hedge fund, private equity, and venture capital to their typical strategy, liquidity, and fund life?
• Do you recall the "2 and 20" fee structure and what a lock-up period restricts?