Due to the risky nature of hedge funds, the Securities and Exchange Commission requires that investors meet certain minimum requirements. An “accredited investor” must meet one of the following prerequisites as defined by the SEC:
- a bank, insurance company, registered investment company, business development company, or small business investment company
- an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million
- a charitable organization, corporation, or partnership with assets exceeding $5 million
- a director, executive officer, or general partner of the company selling the securities
- a business in which all the equity owners are accredited investors
- a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase
- a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year
- a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.
An accredited investor is not to be confused with a qualified client. While both sets of investors are able to put their money into hedge funds, most states will only let hedge fund managers charge a performance fee (usually 20%) to qualified clients. This means that accredited investors are only required to pay the management fee (usually 2%).