Federal ERA status does not exempt you from state regulation. This is one of the most common compliance gaps for private fund managers.
Managers file Form ADV with the SEC, assume they are done, then operate for years without looking at state requirements. By the time the issue surfaces (usually during LP diligence or a state examination), remediation is more complicated than if they had addressed it upfront.
State investment adviser laws apply to any adviser that is not fully registered with the SEC as an RIA. Once you register as an RIA, federal law preempts state registration requirements. But if you are an ERA, you are subject to state regulation in every state where you have a place of business or sufficient clients.
This guide covers how state requirements work, which states are problematic, and what you need to do to stay compliant.
When State Laws Apply
State investment adviser laws apply to:
- Exempt Reporting Advisers relying on the VC adviser or private fund adviser exemptions
- Managers below $25 million who have not made federal filings
- Any adviser who is not registered with the SEC as an RIA
If you are an emerging manager operating as an ERA, you are subject to state regulation. Your federal filing does not change that.
The key triggers are having a "place of business" in a state or having clients (funds) in a state above certain thresholds. A place of business means any office where you regularly provide advisory services, including your principal office, branch offices, and locations where remote employees work.
The NASAA Model Rule
Many states have adopted some version of the NASAA (North American Securities Administrators Association) model rule for private fund adviser exemptions. Understanding this model helps you understand state-by-state variations.
Core Exemption Requirements
The model rule provides an exemption from state registration if you:
- Have no bad actor disqualifications under Rule 506(d)
- File as an exempt reporting adviser through IARD and pay applicable state fees
- Advise only private funds (no separate accounts or other clients)
For advisers who meet these conditions and advise only 3(c)(7) funds or qualifying venture capital funds, that is typically sufficient. The exemption applies.
Additional Requirements for 3(c)(1) Funds
The model rule gets more restrictive for advisers who manage any 3(c)(1) fund that is not a qualifying venture capital fund. If you manage non-VC 3(c)(1) funds, additional requirements apply:
Qualified client requirement
All investors in the fund must be "qualified clients." This is a higher standard than accredited investor. Qualified client currently means: net worth of at least $2.2 million (excluding primary residence), or at least $1.1 million in assets under management with the adviser.
Many accredited investors do not meet qualified client thresholds. An accredited investor with $1.5 million net worth does not qualify. An individual with $250,000 income but modest net worth does not qualify.
Written disclosure
You must provide written disclosure to each investor at the time of purchase covering services provided, duties owed, and material information affecting investor rights.
Annual audit
Each 3(c)(1) fund (other than VC funds) must have annual audited financial statements delivered to investors.
Why This Matters
The qualified client and audit requirements can be deal-breakers for small funds. A manager raising a few million dollars may find their investor base includes accredited investors who are not qualified clients, and the cost of annual audits is prohibitive relative to fund size.
These additional requirements do not apply to 3(c)(7) funds (all investors are qualified purchasers, who easily exceed qualified client thresholds) or qualifying venture capital funds. This creates a meaningful advantage for VC funds and 3(c)(7) structures under state law.
State-by-State Variations
States fall across a spectrum from permissive to highly restrictive.
Permissive States
Some states offer exemptions more generous than the NASAA model rule. These typically exempt advisers based on a simple client count (each fund counts as one client) without the additional 3(c)(1) requirements. States in this category may exempt advisers with fewer than 5, 6, or 15 fund clients in a 12-month period. A few states mirror the federal private fund adviser exemption directly (under $150 million AUM).
States Following the Model Rule
Many states have adopted the model rule with minimal modification. These states provide exemptions but impose the additional requirements on non-VC 3(c)(1) funds: qualified client investors, written disclosure, and annual audits.
Modified Model Rule States
Some states started with the model rule but made adjustments. California, discussed below, added "retail buyer fund" requirements. Other states have made the qualified client or audit provisions more or less restrictive.
Restrictive States
Several states are significantly more restrictive. These states either have no private fund adviser exemption at all, or their exemptions explicitly exclude 3(c)(1) funds. In these states, managing a non-VC 3(c)(1) fund typically means you must register as an investment adviser.
States That Exclude 3(c)(1) Funds
Several states have exemptions that explicitly exclude non-VC 3(c)(1) funds. Managing even a single 3(c)(1) fund that does not meet the venture capital definition means you cannot use the exemption and must register as a state investment adviser.
Delaware
Delaware's exemption is only available to advisers whose clients consist exclusively of "qualifying private funds." Delaware defines this to exclude all 3(c)(1) funds except qualifying venture capital funds.
If you manage a single 3(c)(1) fund that is not a qualifying VC fund, you must register with the Delaware Investor Protection Unit.
Registration triggers significant compliance obligations:
- Custody rule compliance (typically satisfied through annual fund audits)
- Comprehensive recordkeeping
- Written compliance policies
- Periodic state examinations
- Net worth requirements ($35,000 with custody, $10,000 without)
Washington
Washington's exemption only applies to 3(c)(7) funds and advisers who qualify for the federal venture capital fund adviser exemption. Washington's rule references the SEC's VC definition directly.
This creates a trap for managers who have their principal place of business in Washington and manage 3(c)(1) funds that do not meet the SEC's venture capital fund definition.
Because Washington references the SEC definition, secondary transaction SPVs do not qualify for the VC exemption. Secondary purchases are not qualifying investments under SEC rules, even when the underlying companies are startups. A manager running secondary SPVs out of Washington cannot use the state exemption.
Washington registration requirements include Form ADV through IARD, investment adviser representative registration for individuals who provide advice (requires Series 65 or equivalent), compliance program requirements, and custody rule compliance.
Other Restrictive States
Kentucky and North Dakota also have exemptions that exclude 3(c)(1) funds. The specific requirements vary, but the pattern is the same: managing non-VC 3(c)(1) funds triggers registration.
California's Retail Buyer Fund Rules
California has adopted a version of the model rule with an important additional concept that specifically impacts managers of 3(c)(1) funds.
What Is a Retail Buyer Fund?
California defines a "retail buyer fund" as any private fund that:
- Is not a venture capital fund (as defined by SEC rules), AND
- Relies on the 3(c)(1) exclusion rather than 3(c)(7)
In practice, this means most private equity funds, hedge funds, and SPVs that accept accredited investors rather than limiting themselves to qualified purchasers. If you manage 3(c)(1) vehicles in California and they are not qualifying VC funds, they are retail buyer funds.
Requirements for Retail Buyer Funds
If you manage even one retail buyer fund, California imposes additional requirements on each such fund:
Annual audit required
Each retail buyer fund must be audited annually by an independent CPA registered with the PCAOB. Audited financials must be delivered to investors within 120 days after the fund's fiscal year-end (180 days for fund-of-funds). This applies regardless of fund size.
Investor qualifications
All investors must be accredited investors at the time of purchase, or be employees of the adviser, or have acquired interests through gift or inheritance.
Written disclosure
Before or at investment, you must prominently disclose all material facts regarding services, duties, conflicts of interest, and compensation.
Performance fee restrictions
You cannot charge performance-based compensation (including carried interest) to any investor who is not a qualified client. For 3(c)(1) funds, California looks through to individual investors. If you have LPs who are accredited but not qualified clients, you cannot charge them carry.
Practical Impact
The audit requirement creates real costs for small funds. A manager raising $2-3 million for a 3(c)(1) vehicle in California must budget for annual audits regardless of fund size.
The performance fee restriction is equally significant. You must verify qualified client status for each investor before the fund can allocate carried interest to them. This requires tracking investor qualification at a more granular level than federal rules require.
Performance Fee Restrictions Generally
Several states restrict performance-based compensation to qualified clients, even when you are operating under a state exemption.
Qualified client currently means:
- At least $1.1 million in assets under management with the adviser, OR
- Net worth of at least $2.2 million (excluding primary residence)
For 3(c)(1) funds, states that impose this restriction look through to individual investors. You must verify each LP's qualified client status to charge them carry.
This creates operational complexity: tracking qualified client status for each investor, documenting verification in your files, and excluding non-qualified-client investors from performance allocations.
3(c)(7) funds avoid this issue because qualified purchasers ($5 million or more in investments) easily exceed qualified client thresholds.
Registration Consequences
If you cannot qualify for an exemption in your home state or a state where you have sufficient clients, you must register. State registration typically requires:
- Form ADV Parts 1 and 2 filed through IARD
- Investment adviser representative registration for individuals who provide advice or supervise (requires Series 65 or equivalent exam)
- Written compliance policies and designated compliance officer
- Custody rule compliance (usually satisfied through annual fund audits)
- Comprehensive recordkeeping
- Annual registration renewals and Form ADV updates
- State filing fees (vary by state)
State registration adds compliance obligations. It is required if you do not fit within an exemption, and operating without proper registration creates significant regulatory risk.
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This content is for informational purposes only and does not constitute legal, tax, or compliance advice. Consult qualified counsel for guidance specific to your situation. Capital Company is not a law firm and does not provide legal advice.