Every private fund needs an exemption from the Investment Company Act of 1940 to avoid registering as an investment company. The two primary exemptions are Section 3(c)(1), which limits beneficial ownership to 100 persons, and Section 3(c)(7), which removes the investor limit but requires every investor to be a qualified purchaser. Your choice determines your maximum investor count, the minimum wealth threshold for each investor, and how you count investors in complex structures involving trusts and entities.
Section 3(c)(1)
Section 3(c)(1) is the most commonly used Investment Company Act exemption for private funds. It exempts any issuer whose outstanding securities are beneficially owned by not more than 100 persons and that does not make or propose to make a public offering.
The 100-person limit applies to beneficial owners, not record holders. This distinction matters when your investors include trusts, LLCs, partnerships, or other entities that may require look-through counting.
- Maximum of 100 beneficial owners at any time.
- No minimum wealth requirement beyond whatever your Regulation D exemption requires (most commonly accredited investor status).
- Entity investors may need to be "looked through" to count the underlying beneficial owners (details below).
- Knowledgeable employees of the fund or the fund's manager do not count toward the 100-person limit.
- Most emerging and mid-size fund managers start with this exemption because their investor base is small enough to stay under 100 and not all investors are qualified purchasers.
Section 3(c)(7)
Section 3(c)(7) exempts any issuer whose outstanding securities are owned exclusively by persons who, at the time of acquisition, are qualified purchasers, and that does not make or propose to make a public offering.
There is no statutory limit on the number of investors in a 3(c)(7) fund. However, if the fund has more than 1,999 record holders of equity securities, it could trigger reporting obligations under the Securities Exchange Act of 1934. As a practical matter, few private funds approach that number.
- No limit on the number of investors (subject to the 1,999 record holder threshold under the Exchange Act).
- Every investor must be a qualified purchaser: $5,000,000 in investments for individuals, $25,000,000 for entities acting for their own account.
- No look-through requirement for counting qualified purchaser status. If an entity is itself a qualified purchaser, you do not need to look through to its underlying owners for 3(c)(7) purposes.
- The fund still needs a Regulation D exemption for the securities offering, so investors must also meet the applicable Reg D standard (typically accredited investor).
The $5,000,000 threshold for qualified purchaser status measures "investments" specifically, not net worth or income. A person with $10,000,000 in home equity and $3,000,000 in investment securities does not qualify. See Accredited Investors, Qualified Purchasers, and Qualified Clients Compared for a detailed breakdown of what counts as "investments."
Counting Beneficial Owners Under 3(c)(1)
The 100-person limit under 3(c)(1) requires you to count beneficial owners, not just the names on your cap table. The counting rules determine whether entity investors are treated as a single owner or looked through to their underlying holders.
General rule
Each natural person who directly holds an interest in your fund counts as one beneficial owner. An entity that holds an interest generally counts as one beneficial owner, unless look-through applies.
When look-through applies
You must look through an entity to count its underlying beneficial owners if two conditions are both met: (1) the entity holds 10% or more of your fund's outstanding securities, and (2) the entity was formed for the specific purpose of investing in your fund. If both conditions are true, each person who holds an interest in that entity counts separately toward your 100-person limit.
Knowledgeable employees
Directors, executive officers, and certain employees of the fund's investment adviser or general partner who participate in the investment activities of the fund do not count toward the 100-person limit. This exclusion applies only to knowledgeable employees as specifically defined under SEC rules.
Counting examples
- An individual investing directly counts as 1 beneficial owner.
- A family trust investing $500,000 in your $20M fund (2.5%) counts as 1 beneficial owner, regardless of how many beneficiaries the trust has, because it holds less than 10%.
- An LLC formed by 5 friends specifically to invest in your fund, taking a 15% stake, counts as 5 beneficial owners (both conditions met: over 10% and formed to invest).
- A pension fund that has invested across many managers and holds 12% of your fund counts as 1 beneficial owner because it was not formed for the purpose of investing in your fund.
- Two employees of your management company who co-invest in the fund count as 0, provided they meet the knowledgeable employee definition.
Side-by-Side Comparison
| Section 3(c)(1) | Section 3(c)(7) | |
|---|---|---|
| Investor limit | 100 beneficial owners. | No statutory limit (Exchange Act reporting at 2,000 record holders). |
| Investor qualification | No qualification beyond Reg D requirements (typically accredited investor). | All investors must be qualified purchasers ($5M investments / $25M entities). |
| Look-through rules | Required for entities holding 10%+ that were formed to invest in the fund. | Not required. Entity-level QP status is sufficient. |
| Typical fund size | Emerging and mid-size funds, typically under $500M. | Larger funds or funds with many institutional investors. |
| Common users | First-time managers, smaller PE/VC funds, real estate funds with fewer investors. | Established managers, large hedge funds, funds of funds, institutional platforms. |
How to Choose
Start with 3(c)(1) if your investor base will remain under 100 beneficial owners and not all of your target investors meet the qualified purchaser standard. This is the right choice for most first-time fund managers. Your investors only need to be accredited (for Reg D purposes), and the 100-person cap is manageable for funds raising from a focused investor group.
Choose 3(c)(7) if you expect to have more than 100 investors, if your investor base consists primarily of high-net-worth individuals and institutions who are qualified purchasers, or if you want to avoid the complexity of beneficial owner counting rules. Fund-of-funds and institutional platforms commonly use 3(c)(7) because they aggregate capital from many investors.
Planning for future funds
If you start with 3(c)(1) for Fund I and then switch to 3(c)(7) for Fund II, your returning investors must now meet the qualified purchaser standard. Some investors who participated in Fund I may not qualify for Fund II. Consider your long-term fundraising trajectory when selecting an exemption for your first fund.
Can You Switch Between Exemptions?
You cannot switch exemptions for an existing fund once it has accepted investors. The exemption is determined at formation and applies for the life of the fund.
A 3(c)(1) fund cannot become a 3(c)(7) fund by simply requiring all new investors to be qualified purchasers. The exemption covers the issuer, and existing non-QP investors would prevent the fund from satisfying the 3(c)(7) requirement that securities be owned exclusively by qualified purchasers.
You can, however, use different exemptions for different funds in your fund family. Fund I can be a 3(c)(1) fund while Fund II operates under 3(c)(7). Each fund's exemption is independent.
Common Mistakes
Miscounting beneficial owners under 3(c)(1)
The most frequent error is failing to apply look-through rules to entity investors. If a family office LLC was formed to invest in your fund and holds more than 10%, you must count each of its members as a separate beneficial owner. Counting the LLC as a single holder when it should be looked through can push you over 100 without realizing it.
Exceeding 100 beneficial owners under 3(c)(1)
Once you exceed 100 beneficial owners, your 3(c)(1) exemption is no longer available. This does not automatically make your fund an investment company, but it puts you in a precarious position that requires immediate legal attention. Prevention is far simpler than remediation. Track your count carefully and build a buffer. If you are at 90 beneficial owners, start planning your approach to the cap.
Assuming all accredited investors are qualified purchasers
The accredited investor threshold ($1,000,000 net worth or $200,000 income) is far below the qualified purchaser threshold ($5,000,000 in investments). If you form a 3(c)(7) fund and accept an investor who is accredited but not a qualified purchaser, you have violated the exemption's requirements. Verify qualified purchaser status separately from accredited status.
Ignoring trust and estate structures
Trusts are particularly tricky under both exemptions. Under 3(c)(1), a trust that was formed to invest in your fund and holds over 10% requires look-through. Under 3(c)(7), a trust must independently qualify as a qualified purchaser (at least $5,000,000 in investments and not formed for the purpose of acquiring the securities, with investment decisions directed by a qualified purchaser). Do not assume a trust qualifies simply because the grantor does.
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This guide is for informational purposes only and does not constitute legal, tax, or investment advice. The Investment Company Act exemptions described here are subject to SEC interpretation and rulemaking. Consult qualified legal counsel for guidance specific to your fund structure.