Client Types: Synthesis
This synthesis ties together the Client Types topics to help you quickly compare entity characteristics, understand investor classification thresholds, and match client types to exam questions.
Pass-Through vs. Entity-Level Taxation Summary
| Entity Type | Taxation | Liability | Key Characteristic |
|---|---|---|---|
| Sole proprietorship | Pass-through | Unlimited | Simplest structure |
| General partnership | Pass-through | Unlimited (all partners) | Joint management |
| Limited partnership | Pass-through | General partner (GP) unlimited; limited partner (LP) limited | LP cannot manage |
| Limited liability company (LLC) | Pass-through (default) | Limited (all members) | Flexible; can elect corp taxation |
| S-Corporation | Pass-through | Limited | Max 100 U.S. shareholders; 1 stock class |
| C-Corporation | Double taxation | Limited | Unlimited shareholders; multiple stock classes |
Exam Tip: Gotchas
- When a question asks which entity provides BOTH liability protection AND pass-through taxation, the answers are LLC and S-corporation. General partnerships have pass-through taxation but no liability protection. C-corporations have liability protection but double taxation.
Investor Classification Thresholds
These thresholds determine which products and fee structures an adviser can offer. The three levels are nested; each is more exclusive than the last.
Accredited Investor (SEC Rule 501, Regulation D)
Natural persons qualify if they meet ANY of:
- Income: $200,000+ individual income (or $300,000+ joint with spouse/partner) in each of the prior 2 years, with reasonable expectation of the same in the current year
- Net worth: $1,000,000+ (individually or jointly with spouse), excluding primary residence
- Professional certifications: Series 7, Series 65, or Series 82 license holders in good standing
- Knowledgeable employees of a private fund
Entities qualify if they meet ANY of:
- Total assets exceeding $5,000,000 (corporations, partnerships, LLCs, trusts, 501(c)(3)s, employee benefit plans)
- All equity owners are individually accredited investors
- Banks, insurance companies, registered investment companies, business development companies (BDCs)
- Family offices with $5,000,000+ in assets under management (AUM) (and their family clients)
Significance: accredited investors can participate in Regulation D private placements (Rule 506(b) and 506(c))
Qualified Client (SEC Rule 205-3, Advisers Act)
- AUM test: $1,100,000+ in assets under management with that specific adviser
- Net worth test: $2,200,000+ (excluding primary residence)
- Also includes: qualified purchasers, directors/officers/employees of the adviser
Significance: investment advisers can charge performance-based fees (incentive fees) only to qualified clients
Qualified Purchaser (Section 2(a)(51), Investment Company Act of 1940)
- Individuals: $5,000,000+ in investments (excluding primary residence and business property)
- Family-owned companies: $5,000,000+ in investments
- Trusts: $5,000,000+ in investments (not formed specifically for the investment)
- Investment managers: $25,000,000+ under management
Significance: can invest in Section 3(c)(7) funds (private funds exempt from Investment Company Act registration with no investor limit)
Threshold Comparison
| Classification | Individual Financial Test | Entity Test | Primary Significance |
|---|---|---|---|
| Accredited Investor | $200K/$300K income OR $1M net worth | $5M total assets | Reg D private placements |
| Qualified Client | $1.1M AUM with adviser OR $2.2M net worth | Same | Performance-based fees |
| Qualified Purchaser | $5M in investments | $25M for managers | 3(c)(7) fund access |
Exam Tip: Gotchas
- The three thresholds are NESTED, and each level is more exclusive. Accredited investor is the lowest bar, qualified client is in the middle, and qualified purchaser is the highest. All three exclude primary residence from net worth calculations. The exam loves testing which threshold applies to which regulatory purpose.