What it means
The Investment Company Act sets strict rules for funds sold to the general public, covering disclosure, governance and limits on how they operate. Private funds avoid those rules by fitting inside an exemption, and the two most used are named after their sections of the Act.
The exemption is a trade-off, because the fund gives up the public market in return for lighter regulation. A 3(c)(1) fund can have no more than 100 beneficial owners, meaning the real people or entities behind the holdings.
Investors are generally required to be accredited, meaning they meet income or net worth tests set by regulators. Because the investor count is capped, these funds tend to ask for larger minimum commitments.
A 3(c)(7) fund has no fixed cap on the number of investors, but every investor must be a qualified purchaser. This is a higher bar than accredited status and is set by a minimum amount of investments owned, with higher levels for institutions than for individuals.
Larger funds often choose this route because they can accept many investors. For a finance professional, the choice affects fund size, fee structure and who can be approached for capital.
Some managers run both types side by side, with a main fund and a feeder fund (a vehicle that pools investors into the main fund). Counting investors correctly matters, since looking through certain entities can push a 3(c)(1) fund over its limit.
These exemptions are about the Investment Company Act only. A fund can still be subject to securities rules on how it is marketed, and its manager may need to register as an adviser.
The rules and thresholds are set by law and regulators and should be confirmed with counsel. Investors should understand what the exemption means for them.
Because these funds are not registered as public investment companies, they do not give investors the same protections, such as daily pricing and standard disclosure rules. Sophisticated investors accept that trade-off in return for access to strategies that are not available in public funds.
In practice
Real-world examples.
Example
A group of former bankers launches a hedge fund with 60 wealthy investors and uses the 3(c)(1) exemption. They stay below the 100-owner cap and ask for a high minimum investment. The fund avoids the cost of registering as a public fund and can pursue a flexible strategy.
Example
A private equity firm raising $800,000,000 from pension funds and endowments chooses the 3(c)(7) route. All investors are institutions that meet the qualified purchaser test, so there is no cap on how many can join. The firm can therefore keep raising capital until the target is reached.
Example
A venture manager runs a small fund for friends and family and finds a corporate investor holding through a holding company with 40 owners. Counsel advises that those owners may count toward the 100 limit, so the manager reduces the number of new investors it accepts. Careful counting at the outset avoids a forced restructuring later.
Case study
Seen in the real world.
Ridgeway Capital Partners is an illustrative, fictional manager that started with a 3(c)(1) fund of 85 investors, mostly individual professionals. As its track record grew, institutional investors asked to join, and the fund was close to its 100-owner limit.
The partners launched a second fund under 3(c)(7) for institutions and large family offices and left the first fund closed to new money. The two funds invested in the same strategy through a shared management team.
By its third year the 3(c)(7) fund held far more capital than the original and had drawn investors from several countries, while the older fund remained small and personal. The illustrative lesson is that the choice of exemption shapes who can invest and how large a fund can become, so it is a strategic decision as well as a legal one.
Watch out
Common mistakes.
- Assuming the two exemptions mean the fund is unregulated, when securities, adviser and anti-fraud rules still apply.
- Confusing accredited investors with qualified purchasers, which is a much higher test.
- Counting only direct investors and forgetting that some holding entities may need to be looked through when applying the 100-owner limit.
Questions
People also ask.
Which type allows more investors?
A 3(c)(7) fund has no fixed cap on investor numbers, while a 3(c)(1) fund is limited to 100 beneficial owners.
Can a fund switch from one exemption to the other?
It can sometimes be restructured, but it needs legal advice and often investor consent, so most managers choose before launch.
Why do managers use these exemptions at all?
They avoid the cost and constraints of registering as a public investment company while still raising capital from sophisticated investors.
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