Private funds avoid public registration by relying on exemptions from two separate federal statutes: the Securities Act of 1933 and the Investment Company Act of 1940. Each statute has its own exemptions, its own investor qualification standards, and its own filing requirements. Getting any of them wrong can expose your fund to regulatory consequences, rescission rights for investors, or loss of the exemption itself.
Two Layers of Exemptions
Every private fund must satisfy exemptions under both statutes simultaneously. These are independent requirements, and satisfying one does not satisfy the other.
Securities Act Exemption
The fund's interests (LP units, LLC membership interests) are securities. To sell them without registering with the SEC, you need a Securities Act exemption. Most private funds use Regulation D, specifically Rule 506(b) or Rule 506(c).
Investment Company Act Exemption
A fund that pools investor capital and invests in securities is technically an investment company. To avoid registering as one (which would impose mutual fund-style regulations), you need an Investment Company Act exemption. Most private funds use Section 3(c)(1) or Section 3(c)(7).
Regulation D: Securities Act Exemptions
Regulation D provides two primary exemptions for private fund offerings. The choice between them affects your marketing, investor base, and filing obligations.
Rule 506(b)
Rule 506(b) is the traditional private placement exemption. It allows you to raise unlimited capital from an unlimited number of accredited investors, plus up to 35 non-accredited but sophisticated investors. The critical restriction is that you cannot use general solicitation or general advertising to market the offering.
- No general solicitation or advertising (no public marketing, no mass emails to strangers, no social media posts promoting the fund)
- Unlimited accredited investors
- Up to 35 non-accredited sophisticated investors (though including them triggers additional disclosure requirements)
- Issuer must have a "reasonable belief" that each investor is accredited, but no specific verification steps are mandated
- Pre-existing substantive relationship with investors is the standard way to demonstrate no general solicitation
Rule 506(c)
Rule 506(c), added by the JOBS Act in 2013, allows general solicitation and advertising. You can publicly market your fund, post on social media, and host pitch events open to the public. The tradeoff is stricter investor verification.
- General solicitation and advertising permitted
- All investors must be accredited (no non-accredited investors allowed)
- Issuer must take "reasonable steps to verify" accredited investor status, not just rely on self-certification
- Acceptable verification methods include reviewing tax returns, bank statements, brokerage statements, or obtaining written confirmation from a broker-dealer, attorney, CPA, or registered investment adviser
Federal Preemption
One significant advantage of both 506(b) and 506(c) is federal preemption. Under the National Securities Markets Improvement Act (NSMIA), Rule 506 offerings are "covered securities," which means states cannot impose their own substantive registration requirements on the offering itself. States can require notice filings and fees (blue sky filings), but they cannot block a properly conducted 506 offering.
This preemption applies to the securities offering, not to investment adviser registration. Your obligation to register or file as an investment adviser at the state level is a separate question covered by state adviser laws.
Investment Company Act: 3(c)(1) vs 3(c)(7)
The Investment Company Act exemption determines the maximum number and type of investors your fund can accept. The two primary exemptions serve different fund sizes and investor profiles.
Section 3(c)(1)
Section 3(c)(1) exempts funds that have no more than 100 beneficial owners and do not make (or propose to make) a public offering. This is the most common exemption for emerging managers and smaller funds.
- 100-investor limit: The fund can have no more than 100 beneficial owners at any time
- No investor qualification requirement: The Investment Company Act itself does not require investors to be accredited or qualified. However, your Regulation D exemption will impose its own investor standards
- Look-through rules: If an investor is itself a fund or entity formed for the purpose of investing in your fund, you may need to "look through" to count the underlying investors against the 100-person limit
- Integration risk: If you manage multiple funds, the SEC may integrate them and count all investors across funds toward the 100-person limit
Section 3(c)(7)
Section 3(c)(7) exempts funds whose investors are exclusively "qualified purchasers." There is no cap on the number of investors, though practical limits apply.
- No investor limit: The fund can accept an unlimited number of qualified purchasers (though exceeding 1,999 can trigger Exchange Act reporting requirements)
- Qualified purchaser requirement: Every investor must be a qualified purchaser, which is a higher standard than accredited investor
- No public offering: Like 3(c)(1), the fund cannot make a public offering of its securities
Investor Qualifications
The various exemptions reference different investor qualification standards. Which standard applies, and when multiple standards overlap, determines how you structure your fund.
Accredited Investor
Defined under Rule 501 of Regulation D. For natural persons, the primary tests are:
- Individual income exceeding $200,000 (or $300,000 jointly with spouse) in each of the two most recent years, with a reasonable expectation of the same in the current year
- Individual net worth (or joint net worth with spouse) exceeding $1 million, excluding the value of the primary residence
- Holders of certain professional certifications (Series 7, Series 65, Series 82)
- "Knowledgeable employees" of the fund (added in 2020 amendments)
For entities, accredited investor status generally requires $5 million in assets, though certain entity types (banks, insurance companies, registered investment companies) qualify automatically.
Qualified Purchaser
Defined under Section 2(a)(51) of the Investment Company Act. This is a significantly higher bar than accredited investor:
- Natural persons who own not less than $5 million in "investments" (as specifically defined under the Act)
- Family-owned companies with not less than $5 million in investments
- Trusts not formed for the specific purpose of investing in the fund, with not less than $25 million in investments
- Entities acting for their own account or the accounts of other qualified purchasers, with not less than $25 million in investments
Qualified Client
Defined under Rule 205-3 of the Advisers Act. This standard is relevant for performance fee arrangements and certain state registration exemptions:
- Net worth exceeding $2.2 million (excluding primary residence)
- At least $1.1 million under management with the adviser
- "Knowledgeable employees" of the fund
Common Fund Structures
How these exemptions combine in practice depends on your fund's size, investor base, and strategy.
Typical Emerging Manager Fund
Rule 506(b) + Section 3(c)(1). No general solicitation, up to 100 accredited investors, fundraising through existing relationships. This is the simplest and most common structure for a first fund.
Publicly Marketed Fund
Rule 506(c) + Section 3(c)(1). General solicitation permitted, all investors must be verified accredited investors, up to 100 investors. Used by managers who want to market broadly but expect a smaller investor base.
Large Institutional Fund
Rule 506(b) + Section 3(c)(7). No general solicitation, all investors must be qualified purchasers, no investor count limit. Used by established managers raising from institutional investors and high-net-worth individuals.
Parallel Fund Structure
Some managers run parallel funds: one 3(c)(1) fund for accredited investors and one 3(c)(7) fund for qualified purchasers. This allows them to accept a broader range of investors while avoiding the 100-investor limit for their larger commitments.
VC Fund vs PE Fund Classification
The SEC draws a distinction between venture capital funds and other private funds. This classification affects your adviser registration obligations under the Advisers Act.
A "venture capital fund" under Rule 203(l)-1 must meet specific criteria: it primarily invests in qualifying portfolio companies (private operating companies), does not borrow or use leverage beyond short-term borrowing of up to 15% of capital, does not offer redemption rights to investors, and represents itself as a venture capital fund. Advisers who exclusively advise venture capital funds can rely on the Section 203(l) exemption from SEC registration.
Funds that do not meet the venture capital fund definition are classified as private funds. Advisers to private funds with less than $150 million in assets under management in the United States can rely on the Section 203(m) exemption. The choice of exemption has implications for your ERA filing and for state-level registration requirements.
Form D Alignment
Your Form D filing must accurately reflect the exemptions you are relying on. The form asks you to identify:
- Whether you are relying on Rule 506(b) or Rule 506(c)
- The Investment Company Act exemption (3(c)(1) or 3(c)(7))
- The number and types of investors who have invested
- The amount of capital raised
Inconsistencies between your Form D and your actual fund structure can draw SEC scrutiny. If you start with a 506(b) offering and later decide to engage in general solicitation, you need to amend your Form D to reflect 506(c) and ensure all investors are verified accredited investors.
How Capital Company Helps
Capital Company provides digital investor onboarding, including subscription documents, investor questionnaires, and qualification verification. Schedule a demo to learn more.
This content is for informational purposes only and does not constitute legal, tax, or compliance advice. Securities exemptions are complex, and the requirements described here are simplified summaries of the applicable rules. You should consult with a qualified securities attorney before structuring your fund or relying on any exemption. Capital Company is not a law firm and does not provide legal advice.